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Saudi could be upgraded to emerging markets status by MSCI in 2019

Global index compiler MSCI said on Tuesday it would consider upgrading Saudi Arabia to emerging market status, a move that would attract tens of billions of dollars of fresh foreign money as the country seeks to diversify its economy beyond oil.

MSCI will announce its decision in June 2018, and any move to upgrade would take effect in two phases – in May 2019 and August 2019.

Riyadh opened its market, the Arab world’s biggest, to direct investment by foreign institutions in June 2015 and has been bringing its settlement and other systems closer to international practice since then. So many fund managers expect a positive decision.

“Inclusion in the MSCI Emerging Markets Index would be a transformative catalyst not just for Saudi Arabia’s stock market but for exchanges throughout the entire region,” said Bassel Khatoun, chief investment officer for Middle Eastern and North African equities at Franklin Templeton Investments.

“With approximately $2 trillion in active and passively managed money tracking it, MSCI’s EM Index is a significant dictator of equity market flows. Inclusion into MSCI EM will put Saudi, and the MENA region, firmly on the radar of international investors.”

MSCI estimated 32 major Saudi stocks would gain emerging market status, giving the country a potential weight of 2.4 per cent in its index.

That calculation does not include the planned public offer in late 2018 of a roughly 5 per cent stake in national oil giant Saudi Aramco, expected to be the world’s biggest IPO.

Listing Aramco in Riyadh would approximately double Saudi Arabia’s weighting in the emerging markets index, fund managers estimate, possibly making the kingdom a bigger presence in the index than Russia and Mexico.

Fund managers estimate an MSCI upgrade – as well as an expected decision by FTSE this September to lift Riyadh to secondary emerging market status – could bring over $50bn of foreign money into the country in the next few years. That estimate includes “passive” funds which track indexes as well as actively managed funds.

The Saudi market currently has a capitalisation of about $445bn. With the economy and state finances squeezed by low oil prices, Riyadh is eager to attract foreign capital, partly to help improve the management of Saudi companies.

But an MSCI upgrade would not guarantee a strong rally in share prices from current levels. The bourse is not cheaply valued – its 12-month forward price-earnings ratio is 13.9, while the MSCI Emerging Market Index is at about 12 – and the economy faces difficult times in the next few years.

The government is imposing austerity policies to cut a huge budget deficit and will introduce a value-added tax next year. Partly because of such pressures, all types of foreign investors currently own only a little more than 4 per cent of the market.